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It’s going to double: Machin

For decades the most famous foreigner in China was Norman Bethune, a Canadian doctor about whom Mao Zedong wrote a famous eulogy. Bethune saved countless lives during the Japanese invasion and subsequent Chinese civil war, thanks to his medical skills. In Mao’s essay – which still appears in school textbooks – the Chinese leader praised the Canadian with the memorable line: “We must all learn the spirit of absolute selflessness from him.”

Bethune’s commitment is a historical pillar of Sino-Canadian amity, but in recent years Canada has reinforced the ties with a financial commitment to China’s future. Over the past decade the Canada Pension Plan Investment Board (CPPIB) has ramped up its exposure to Chinese economic growth through a range of astute investments. The C$366.6 billion fund ($283.7 billion) has 10.1% of its portfolio in Greater China, of which C$28 billion is directly invested in the mainland. WiC talked to Mark Machin, CPPIB’s president and CEO, about the pension fund’s history in China and its plans to double its Chinese exposure.

Can you discuss the fund’s investment history in China?

We were founded as a fund just under 20 years ago and for the first few years we were a passive investor. In 2006 the strategic decision was made to turn CPPIB into a global active investor. Getting on with that in 2007, one of the first things we decided to do was open an office in Hong Kong. We started investing in Asia and China from 2008 onwards. In those 10 years it’s been a case of so far, so good. We gradually expanded the strategies we have in China from fund investment to more direct equity investment, and private equity investment and real estate. We are looking into other strategies. For instance, we don’t do anything in infrastructure right now and at some stage we’ll look at that. We have also dipped our toe into private credit, though have not done a huge amount.

There’s news that you plan to substantially increase the fund’s China allocation…

We have announced a strategic direction plan stretching out to 2025. As part of that there is a goal to be up to 33% invested in emerging markets and of those the main ones we’ll focus on are China, India and Brazil. And China will be the largest. We’re expecting it to reach 20% of the fund’s allocation over the next decade. I am not sure what year that will be – it depends on the opportunities, so reaching that percentage may occur be a couple of years after 2025. But probably about half of our exposure in emerging markets will be in China.

That implies the fund is still bullish on the China growth story…

Yes. Personally I am constructive on China in the longer term. We have the ability to invest onshore in China via QFII, Stock Connect and domestic private equity. We have broad access to opportunities in China, so an easy way to look at it from CPPIB’s perspective is “prudent diversification”. We have 40% of our money in the US and currently have around 8% in mainland China. These are the world’s largest- and second-largest economies and gradually those allocations are going to converge as the two economies converge in size.

The second perspective is a belief that there are extraordinary value creation opportunities in China. Markets there can be less efficient at times and, one day it will be the biggest economy in the world. So it’s true we see the Chinese growth story continuing.

How big is the Hong Kong office?

We now have over 100 people in Hong Kong. We don’t yet have an onshore team in mainland China. We have small offices in Australia and India, while a majority of regional investments are driven from Hong Kong. Around 25% of our portfolio is now in Asia. So we think it’s quite reasonable to have 100 people in Hong Kong out of 1,500 in total.

In Hong Kong we have teams who are doing private equity investments, looking at private equity funds, hedge funds, public markets investing, real estate, principal credit and so forth. It could get bigger; we could add an infrastructure team, for example.

You have a $3 billion QFII allocation. Do you buy additional A-shares through the Hong Kong Stock Connect schemes with Shanghai and Shenzhen? How do you assess the success of these market access reforms?

Yes, we can do that. The domestic market reforms in China have been really encouraging and reflect a growing maturity. It’s terrific that they are opening up in this way, and in a gradual way and prudent way. It’s got a ways to go and will have to weather some stress, but it is a sensible direction.

When did the fund first start buying A-shares?

Around six years ago when we first got our QFII allocation, which we later significantly increased. We have been buying Chinese stocks since 2008, but initially only those that were listed in Hong Kong. When I joined in early 2012, I recall my first conference call was about QFII. Part of it is managed internally, and part by external fund managers. And increasingly we are investing directly in A-shares via Stock Connect and have a team working on that.

What did MSCI’s decision to include A-shares mean for the fund?

That’s not something that’s so relevant to us but from the perspective of the overall opening up of the market it was encouraging. Regardless of MSCI decisions we would be diversifying into the A-share market anyway. We think it’s a market where long-term investors can find significant value over time. We’ve found good managers to work with us and found that long-term ownership does work in that market. We have had success investing on our own in the A-share market.

Based on your disclosures, it is quite clear the fund has made some astute stock picks over the past decade. You were a fairly early investor in internet giants Alibaba and Tencent, for instance.

Yes, they are terrific investments. We always wish we’d bought more and bought earlier. But buying Alibaba in 2011 was good. We did that alongside Silver Lake and then we added more in 2012 and bought more through the IPO and added to our public position after that. So we are a big long-term holder and continue to believe in the long-term growth story.

Is healthcare a key investment theme? CPPIB is a shareholder in Ping An’s Good Doctor…

We are not taking a contrarian view on China, so the things we want to get exposure to are a rising middle class, rising consumption of healthcare, education, access to financial services. So growing consumption is a big theme as is the aging demographic – and what their needs will be over time. Healthcare is key to that aging demographic and so is an area we want to invest in.

The fund is the ninth biggest shareholder in Midea. Is that a play on robotics and the replacement of a shrinking workforce?

That is one element of the equity story. With a declining workforce there has to be an increase in productivity for economic growth to continue. So robotics and automation is going to be a key part of that, and will spur that investment over time.

Your private equity team has backed some winners too, such as Meituan Dianping which listed last week at a valuation of over $50 billion. CPPIB invested in two earlier rounds at valuations of $7 billion in 2015 and $30 billion last year…

We are pleased with that investment. Wang Xing is an extraordinary entrepreneur and has built an impressive business. The private equity team has performed well and we’d love to make more scale investments over time. For instance, $600 million into Ant Financial was substantial; the Nord Anglia privatisation [it operates international schools in Hong Kong and China and elsewhere] involved $1 billion underwriting alongside Barings. We like to find more substantial private equity opportunities that we can work with partners on.

And the current themes you like for private equity are areas such as O2O and fintech?

Yes, and education and healthcare. We will look at every industry but the ones that have a connection to our investment themes are preferred. We have a number of investments around the world that are trying to find value in the aging demographic. For example, in Europe we are the biggest shareholder of Orpea, the largest listed managed care provider which is also trying to build a network of facilities in China [see WiC367 for more on this French company, which specialises in Alzheimer’s care] It has opened in Nanjing and is expanding its operations in China.

We also have an interesting investment in a river cruise business in Europe: Viking Cruises. That is also taking advantage of the aging US baby boomers demographic, now pursuing a retirement lifestyle who want to go and see Europe. We are looking for similar style investments in China where we are moving from one-sixth of the population being over 60 today to one-third by 2050.

Is there a China dimension here too – in Viking’s case the rapid rise in overseas Chinese tourism, or helping Orpea to expand in China?

Viking is looking at China and that huge market where they can bring their experience. A business model for elderly assisted living and healthcare in China has yet to be developed to help the aging population. Enormous amounts of capacity needs to be built.

You cooperate with external managers like Hillhouse. Given the level of internal expertise you have, what is the value-add of working with outside managers?

I am proud of our team but we are humble enough to know we don’t have every bit of expertise. Even with 100 people in Hong Kong, Asia is vast and complicated and China alone is vast and complicated. So we need to work with partners whether they are real estate developers, asset managers, or private equity players like Hillhouse who have enormous depth of research and relationships. They bring a lot of insight and skill.

CPPIB has big property investments in second-tier cities. Is this a bet on the ubanisation story?

Yes, although we are invested in both first- and second tier-cities. With CapitaLand we are invested in the Raffles City projects and with Capital Malls in a range of retail properties. With Longfor we now have four retail investments in Shanghai, Suzhou, Chengdu and Chongqing. In logistics we have 42 different warehouse sites across China with Goodman and that’s a little bit broader than just first-and-second tier [cities]. Despite the huge amount of building that’s going on in this sector, I still think it’s a massively under-resourced area of real estate. There is a massive demand for logistics space. It’s necessary just to facilitate more trade across the country.

Logistics is a terrific story. We also have shopping malls with Longfor and we still think that even with the growth of e-commerce there is still a demand for destinations like big malls that are properly curated and managed. We have been increasingly satisfied with those malls and then general commercial real estate projects like the Raffles City projects, which have benefited from increasing urbanisation.

The $4 billion in Goodman Logistics warehouses is a proxy for the e-commerce boom in China?

Yes, though it sort of started before e-commerce took off. It started out with not having many e-commerce tenants, to a significant proportion of those warehouses now being devoted to e-commerce. So it has really benefited from that. We saw that coming from our earlier investments in e-commerce, but equally we had a thesis that even if e-commerce doesn’t take off to the degree we expect, there is still a paucity of modern logistics warehouses in China – and they are needed for internal trade, let alone e-commerce. It was a robust story, but e-commerce has proven a great driver. The challenge is finding the land and getting permission for development. It’s not the most exciting type of real estate for local authorities.

Given the rise of e-commerce, how do keep your malls attractive?

We’ve studied this pretty carefully around the world and we are quite happy with our shopping mall developments. The one area where we have to be careful is the US, where overbuilding is massive – there are something like 1,200 malls in the US and estimates predict that will decrease to 300 over the next few years. There are going to be an enormous number of closures of malls. At the other end of the spectrum are our Indian shopping malls where there are few high-end projects and we are delighted with our joint venture with Phoenix Mills.

I’d say China is much closer to India than the US, though it has had a boom in shopping mall development after 2012 when a lot of residential developers tried building them. But it is not just about building a mall. It’s about managing and curating and making sure you have the right range of shops and services and restaurants and attractions. It takes a lot of skill and effort. Lots of residential developers have now realised it is much harder than they thought and that’s why some of the malls in China have not worked. We’ve worked with some fantastic experienced players – Capital Malls has 6,000 or so people onshore in China running these malls and has really deep teams who know what they are doing. People shouldn’t underestimate the enormous amount of management that’s needed to keep your mall interesting, vibrant and a place people want to go to. It’s becoming more and more about entertainment and turning the mall into a destination.

I also believe that even in a world where people increasingly buy things for home delivery that people still like to go out and share experiences together. That’s why movie theatres – which many thought would be obsolete 20 years ago – are booming along with live shows and live entertainment. So you have to make malls somewhere where you can go to share experiences.

What attractions does the fund see in the Chinese bond market?

It is early days for us there, to be honest. The attraction is it’s absolutely huge: an $11 trillion market. Within the second-biggest bond market in the world there is going to be value. We are dipping our toes in at the moment, understanding how the market works – its part of a small emerging market fixed-income portfolio we’ve been building over the past year.

Are you buying corporate bonds or government bonds?

It is more government – we’re not buying one bond versus another bond. We’re trying to create a market exposure at this stage. We do have a principal credit team that does invest in mezzanine and the higher-yield parts of the capital stack. That team has made a handful of investments in China.

One big deal we did was the financing for the sale of The Center in Hong Kong to a group of private investors. We were part of the debt stack there. We’ve done some other high-yield lending in China too.

As your exposure grows, are levels of default risk a concern?

The rising default risk is healthy. The ratings were ridiculously high, the default rates ridiculously low. Generally it is healthy if the market moves to more transparency on rating and is able to absorb more defaults. This way there isn’t an expectation that some level of government is going to step in and resolve every default. There’s been a lot of moral hazard in the bond market and it’s important it moves towards being a more grown-up market. If you default, you suffer the consequences as a company.

Is green finance a priority?

We did a green bond about a month ago, a $1.5 billion financing. We were the first pension fund to do so. That’s part of diversifying our sources of funding and liquidity; and we have a growing need as we invest in wind, solar and other renewables. We have invested in wind in the US and Brazil, and in solar in India. Nothing in China yet, but I imagine that will happen over time.

Your own involvement in the Chinese capital markets goes back to the genesis of their opening up, when you were a banker in Hong Kong…

I arrived in Asia in the fall of 1994 when the second batch of H-shares like Huaneng Power was just going public. Then markets shut and I later caught the red chip bubble. But the big, big IPOs that were game changing were those like China Mobile in 1997 and PetroChina in 2000. I can’t claim to have been there right back at the very beginning but it has been a privilege to have been a tiny part of the process and working on IPO deals like China Mobile, PetroChina, Bank of China and Ping An and onwards. I have a huge amount of warmth and affinity for the development of the Chinese capital market. They continue to evolve and I am glad to still be a part of it in a small way.

In terms of concerns, do you worry about a bifurcation into a US business ecosystem and a Chinese one, driven by tech rivalry and trade wars?

We are in favour of, and beneficiaries of, open capital markets and open trade flows. So I hope things evolve in that direction. These economies are going to be highly connected, even with tariffs. I don’t think we ever roll back to unconnected markets. Those days are long gone. They’re history.

Even with the national security concerns over tech leadership?

An enormous amount of tech research is global, transparent and shared. Science itself is generally published. I think there may be a push by China to be not totally reliant on the US for imports of semiconductors, however. I am sure there will be moves to eliminate that vulnerability and have a homegrown semiconductor industry.

Are you concerned about environmental risk in China, for instance water shortages?

We are believers in climate change and think it is a very significant risk. We have a lot of work underway on how to price and understand the risk – in our portfolio and with every investment we make. It’s a big issue and we are about to publish our annual Sustainable Investing Report, updating our stakeholders on progress in this area. It’s real and water shortages are a key part of that. It’s one of the five areas of sustainable investing we are focused on around the world – encouraging companies to be more efficient in their use of water.

Finally, what can CPPIB teach China about pension reform?

We have a three-year project with the NDRC to research the aging population and the provision of care, as well as the policies required. Canada has been a leader on the pension side and more broadly on the provision for an aging population. We are trying to communicate and deliver the best experiences from Canada to assist Chinese policymakers.

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